Here’s the news of the week – and how we see it here at McAlvany Wealth Management:
Gold and Oil Are Still the Big Story
It has been an eventful few weeks since we put out our last Hard Asset Insights commentary with some of our outlook for 2020. The broader market continues to make new highs and climb “the wall of worry,” though that wall includes escalation of tensions in the Middle East, no definitive resolution on trade, decelerating earnings growth in 2020, declining confidence in the C-suite; a decidedly elevated risk environment, and indications that the rally is largely driven by liquidity.
We kicked off the year with the assassination of Qasem Soleimani on January 3, which was decidedly a watershed event in Middle East relations. We saw both gold and oil spike afterward, along with related stocks. However, though both spiked on this event, we tend to look at them as having separate dynamics with different implications for investment outcomes. We saw gold cross the $1600 level, but, as a general rule, spikes on geopolitical events alone tend to be short-lived. The rally was a seven-year high and a technical breakout after months of consolidation, but was achieved in extremely overbought conditions. When the risk-off fears of “World War 3” began to dissipate, the rally proved to be fleeting.
To be clear, we believe the medium- to long-term backdrop for the yellow metal is quite favorable, but not for the reasons the shorter-term geopolitical drivers would suggest. We are far more inclined to accumulate positions in preferred gold stocks in the face of globally easy monetary policy, currency debasement, global mine site declines, and an uncorrelated portfolio diversifier. Shares are particularly attractive given that industry discipline will result in rising earnings estimates, NAVs, and higher free cash flows as Q4 2019 earnings season begins to draw near.
Energy is an interesting and perhaps more fundamentally driven situation. Until recently, there has been zero geopolitical premium in the oil price – much of which is directly related to the North American shale revolution having turned the entire global cost curve on its head. In fact, if an event like Soleimani’s death had occurred prior to the shale revolution, we would likely see oil at well over $100 a barrel. To a degree, we believe that part of the move we’ve seen in the last week or so is something of a mean reversion for a universally hated asset class as much as a reaction to the prospect of a broader regional conflict. What’s more, this is all happening at a time when global inventories are drawing down.
At least for now, it does not appear that we will see any significant escalation in tensions with Iran. Despite the pullback since Iran launched ballistic missiles at US airbases in Iraq, we think the market will maintain at least some risk premium around elevated tensions in the region. The United States has taken out a very key Iranian asset in Soleimani, and it is unlikely we have seen the end of this, despite the Iranian UN ambassador suggesting otherwise.
Additionally, although we are hearing that oil producers are aggressively hedging their 2020 capital budgets at current prices, we believe that the healthiest producers will maintain discipline and allocate free cash toward debt reduction and deleveraging, share buybacks, and boosting dividends. Although we are likely to see balance sheet write offs for year-end 2019, these are largely backward looking. As the industry struggles with having lost capital market relevance and having shrunk from 20 percent of the S&P 500 to four percent, they recognize that they have zero mandate to grow, and must become more returns-focused. This supply discipline, coupled with OPEC+ compliance, will bode well for prices.
We greatly appreciate your interest and thank you for your continued support. All the best for a happy, healthy, “golden” new year.
Chief Executive Officer
DISCLAIMER: The views expressed in any linked articles herein are those of the article’s author and do not necessarily reflect the views of McAlvany Wealth Management (MWM). MWM did not participate in the preparation of the linked articles and while the linked articles are believed to be from reliable sources, MWM does not guarantee their accuracy.